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Pricing and Customer Value. Phil Kaminsky kaminsky@ieor.berkeley.edu. David Simchi-Levi Philip Kaminsky Edith Simchi-Levi. Outline. Customer Value The Fundamentals of Pricing Strategies Revenue Management & Customized Pricing Mail-in-Rebate strategies Dynamic Pricing in SCM
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Pricing and Customer Value Phil Kaminskykaminsky@ieor.berkeley.edu David Simchi-Levi Philip Kaminsky Edith Simchi-Levi
Outline • Customer Value • The Fundamentals of Pricing Strategies • Revenue Management & Customized Pricing • Mail-in-Rebate strategies • Dynamic Pricing in SCM • Delayed Pricing vs. Delayed Production
Customer Value • How should a company measure the value of its products or services? • The emphasis has moved from internal measures such as quality to customer satisfaction measures. • The supply chain has a huge impact on perceived customer value: • Prices vs. service? • Delivery speed vs. price? • Specialization or one-stop shopping? • Recall that responding to customer requirements is a basic part of supply chain management. • Customer value drives changes in the supply chain, and is a critical input in determining the type of supply chain for a particular product • Large inventories • High level of customization
The Dimensions of Customer Value • Conformance to requirements • Offer what the customer wants • Demand impacts the supply chain • Product Selection • A proliferation of options makes the supply chain difficult to manage • Three trends • Specialty stores (Starbucks, Subway) • Megastores (Wal-Mart, Target) • Specialized Megastores (Home Depot, OfficeMax) • Dealing with the proliferation: • Build-to-order • Centralized inventories • A fixed set of options
The Dimensions of Customer Value • Price and Brand • Pricing is a key part of the customer experience • The correct supply chain supports the correct price • Wal-mart • Brand works hand in hand with price • As the number of salespeople decreases, the value of brand increases • This is particularly true on the internet • Value Added Services • It is hard to compete on price alone • Value added services are on the rise due to • Commoditization of products • The need to get closer to the customer • Improving information technology • Relationships and Experiences • An increased connection between the firm and its customers • Dell manages the PC’s of large customers • 3PL • The Sony store
Smart Pricing? • Dell: • Same product is sold at a different price to different consumers (private/small or large business/government/academia/health care) • Price of the same product for the same industry varies • Amazon • Books.com had a lower price than Amazon 99% of the time, yet Amazon had 80% of the market in 2000 while Books.com only 2% • Nikon, Sharp… • Mail-In-Rebate • Boise Cascade office • Prices of 12,000 items sold on-line may change as often as daily
Revenue Management • Example: • A cruise ship with C=400 identical cabins • The Price-Quantity relationship
Revenue Management 2000 Price P=2000-2Q 1000 No. seats
Revenue Management • Example: • A cruise ship with C=400 identical cabins • The Price-Quantity relationship • What is the price that the company should charge to maximize revenue?
Revenue Management Price Revenue=480,000 P0=1200 C=400 No. seats
Revenue Management Price Money on the Table=160,000 P0=1200 C=400 No. seats
Revenue Management Price P2=1600 Q2=200 No. seats
Revenue Management Price P1=1200 C=400 No. seats
Revenue Management Price Revenue=1600(200) + 1200(400-200)=560,000 P2=1600 P1=1200 Q2=200 Q1 =400 No. seats
Revenue Management • Can we increase revenue more?
Revenue Management Price P3=1800 Revenue=1800(100) + 1600(200-100) + 1200(400-200)=580,000 P2=1600 P1=1200 Q2=200 Q3=100 Q1 =400 No. seats
Sensitivity to Duration Sensitivity to Flexibility Low High Sensitivity to Price High Low How can the firm prevent customers from moving from one class to another? Leisure Travelers No Demand No Offer Business Travelers
Revenue Management • “Allocating the right type of capacity to the right kind of customer at the right price so as to maximize revenue or yield” • Traditional Industries: • Airlines • Hotels • Rental Car Agencies • Retail Industry
Traditional Requirements • Perishable inventory • Limited capacity • Ability to segment markets • early-bird booking • over the weekend • Product sold in advance • Fluctuating demand
Airline Revenue Management • Two components of airline revenue maximization: • Customized Pricing: • Various “fare products” offered at different prices for travel in the same O-D market • Yield Management (YM): • Determines the number of seats available to each “fare class” on a flight, by setting booking limits on low fare seats
Revenue Management:Yield Management • There are only two price classes • Leisure: (f2) $100 per ticket • Business: (f1) $250 per ticket • Total available capacity= 80 seats • Distribution of demand for business class is known
Revenue Management:Capacity Allocation • There are only two price classes • Leisure: (f2) $100 per ticket • Business: (f1) $250 per ticket • Total available capacity= 80 seats • Distribution of demand for business class is known • Enough demand for the leisure class
Revenue Management:Capacity Allocation • Objective: How many seats to allocate to the business class to maximize expected revenue
Revenue Management:Capacity Allocation • Optimality Condition: Choose the number of seats for the business class such that marginal revenue from each class is the same
Optimality Condition Marginal Revenue Leisure
Optimality Condition Marginal Revenue Leisure
Benefits of Revenue Management in the Airline Industry • Evidence of airline revenue increases of 4 to 6 percent: • With effectively no increase in flight operating costs • RM allows for tactical matching of demand vs. supply: • Booking limits can help channel low-fare demand to empty flights • Protect seats for highest fare passengers on forecast full flights
Mail-in-Rebate • What is the manufacturer trying to achieve with the rebate? • Why the manufacturer and not the retailer? • Should the manufacturer reduce the wholesale price instead of the rebate? • Are there other strategies that can be used to achieve the same effect?
Mail-in-Rebate • A Retailer and a manufacturer. • Retailer faces customer demand. • Retailer orders from manufacturer. Variable Production Cost=$200 Selling Price=? Manufacturer Retailer Wholesale Price=$900
Demand-Price Relationship 10000 Demand P=2000-0.2Q 2000 Price
Retailer Expected Profit (No Rebate) $1,370,096
Manufacturer Profit (No Rebate) $1,750,000
Retailer Expected Profit ($100 Rebate) $1,644,115
Manufacturer Profit ($100 Rebate) $1,810,392
Retailer Expected Profit (Reduced Wholesale Price $100 ) $1,654,508
Manufacturer Profit (Reduced Wholesale Price $100) $1,800,000